Internal And External Economies Of Scale


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Internal And External Economies Of Scale

When a company reduces costs and increases production, internal
economies of scale have been achieved. External economies of scale
occur outside of a firm, within an industry. Thus, when an industry's
scope of operations expand due to for example the creation of a better
transportation network, resulting in a subsequent decrease in cost for
a company working within that industry, external economies of scale
are said to have been achieved. With external ES, all firms within the
industry will benefit.

Economies Of Scale

In addition to specialization and the division of labor, within any
company there are various inputs that may result in the production of
a good and/or service:

* Lower input costs: when a company buys inputs in bulk, say for
example potatoes used to make French fries at a fast food chain;
it can take advantage of volume discounts. (In turn, the farmer
from which sold the potatoes could also be achieving ES if the
farm has lowered its average input costs through, for example,
buying fertilizer in bulk at a volume discount).

* Costly inputs: some inputs, such as research and development,
advertising, managerial expertise and skilled labor are expensive,
but because of the possibility of increased efficiency with such
inputs, can lead to a decrease in the average cost of production
and selling. If a company is able to spread the cost of such
inputs over an increase in its production units, ES can be
realized. Thus, if the fast food chain chooses to spend more money
on technology to eventually increase efficiency by lowering the
average cost of hamburger assembly, it would also have to increase
the number of hamburgers it produces a year in order to cover the
increased technology expenditure.

* Specialized inputs: as the scale of production of a company
increases, a company can employ the use of specialized labor and
machinery resulting in greater efficiency. This is because workers
would be better qualified for a specific job, for example someone
who only makes French fries, and would no longer be spending extra
time learning to do work not within their specialization (making
hamburgers or taking a customer's order). Machinery, such as a
dedicated French fry maker, would also have a longer life as it
would not have to be over and/or improperly used.

* Techniques and Organizational inputs: with a larger scale of
production, a company may also apply better organizational skills
to its resources, such as a clear-cut chain of command, while
improving its techniques for production and distribution. Thus,
behind the counter employees at the fast food chain may be
organized according to those taking in-house orders and those

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dedicated to drive-thru customers.

Types of Economies of scale

Description

Can it be diseconomies of scale

Technical economies.

They are found mostly in plants and arise mostly because neither the
capital cost nor the running cost of plants increase in proportion to
their size. The main idea is to spread the fixed costs over as large
output as possible, so AFC decreases.

yes

Internal diseconomies of scale include technical diseconomies, which
include the further cost of enormously big plants and their relatively
big loss, when one part fails.

Economies related to industrialization

If there is a great concentration in specific place, e.g. many people
come to look for job there. Usually the communication expenses
(maintenance of roads) can be shared. The activities of the essential
services sector multiply, providing more advantages to firms in the
industrialized area.

External diseconomies

of scale arise mostly as a result of the overcrowding of industrial
areas. This will lead to the increase in the price of land, labour and
services. An obvious example is the congestion costs resulting from
high traffic densities.

Financial economies

arise because e.g. the interest rate for getting a loan is higher for
smaller firm that for larger one. This is because large firms have
large assets and bank trusts them more. It is also relatively easier
for large firms to raise their share-capital by issuing shares.

no

Marketing economies.

They are available both in purchases of raw material and in selling of
the product. A large firm may have a bulk discount when purchasing raw
materials. In terms of promotion, to large firms the average cost is
smaller, because the prices of advertisements are the same for all
firms.

no

Managerial or administrative economies arise because the same people
can usually manage with bigger output, so average administrative cost
decreases when production increases. Large firms can employ
specialists, which leads to the increase in efficiency.

arise because the same people can usually manage with bigger output,
so average administrative cost decreases when production increases.
Large firms can employ specialists, which leads to the increase in
efficiency.

yes

Administrative

diseconomies are also existing. It is relatively expensive to inform
staff in big firms, also the obeying of commands may take very long
time.


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